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05-03-2025
An update on the climate change regulatory landscape
As the prospect of deregulation dominates the start of 2025, the cost of inaction remains patently clear.
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The climate change regulatory landscape has evolved rapidly since the publication of our whitepapers, Climate Stress Testing and Now or Never for Financial Services. This update provides an overview of current climate regulations and recent policy developments. Understanding the regulatory environment helps organisations ensure compliance and identify opportunities for innovation and sustainability.
Update on climate science
In 2023, the Intergovernmental Panel on Climate Change (IPCC) released the Synthesis Report of its Sixth Assessment Report—IPCC (AR6), which analysed the current status and trends, long-term climate and development futures, and near-term responses for a changing climate. Among studies on mitigation, vulnerability, and adaptation, a key component of the report was the development of the Shared Socioeconomic Pathways (SSPs) in the projection of future climate scenarios. These build on the existing Representative Concentration Pathways (RCPs), which project future scenarios solely on greenhouse gas emissions, by incorporating socioeconomic development factors and potential changes in policy. The report's prediction that all options would likely lead to exceeding the 1.5°C target came true last year, serving as another reminder of how important it is to take action to reduce climate change. It also shows that extreme weather events are becoming more common and getting worse, so businesses need to adapt to stay strong and have the best chance of avoiding disruption.Regulatory landscape update
To combat these developing risks, by making sure organisations are prepared and that governments, investors, and the public are sufficiently informed, climate-related regulation has evolved dramatically in recent years. After bringing forward a broadly accepted climate reporting framework, the Task Force on Climate-Related Disclosures (TCFD) working group was disbanded in 2023, with the IFRS now responsible for overseeing disclosures from included companies. The EU’s regulatory landscape has also developed, with the Taxonomy, Corporate Sustainability Reporting Directive (CSRD), and Corporate Sustainability Due Diligence Directive (CSDDD) all coming to the forefront of ESG reporting requirements.
As we tentatively settle into another new normal after 2024, ‘the year of elections,’ there has been huge pushback on these reporting requirements emerging from the political sphere in a bid to reduce administrative and cost burdens and to give resurgence to waning competitiveness.
At the time of writing, the EU has just published its ‘Omnibus’ package proposal, an initiative put forward to address this issue of “burdensome reporting”, which includes a simplification to regulatory requirements for companies operating in EU countries. Each framework is still a part of EU law, even though it has changed in some ways, like applying only to companies with more than 1,000 employees and giving companies more time to file their reports in line with the CSRD.
As this regulatory landscape continues to evolve, natural disasters are increasingly wreaking havoc on civilisations around the world. Munich Re reports that, in 2024, natural catastrophes took 11,000 lives, led to $320 billion in global losses, and accounted for 93% of overall losses for the year. Flash flooding devastated Valencia as a year’s worth of rainfall fell in just one day, and Hurricane Milton caused over $50 billion of damage. These ever-more common societal and economic catastrophes are examples of why extreme weather events are recognised in the World Economic Forum’s 2025 Global Risks Report as the second-biggest short-term risk (2 years) and the biggest risk over the long term (10 years). While the prospect of deregulation dominates the start of 2025, the cost of inaction for both businesses and communities remains patently clear.
Evolving approach of the insurance sector
The insurance market has been actively adapting to the intensifying physical climate risks in recent years. An example of one such adaptation is the increasing uptake from insurers of dual or even several hazard data models to incorporate into their forward-looking climate-related analysis. These are then combined with already complex analytics structures in the form of integrated assessment models (IAMs), which build on the various emissions scenarios and add further layers of modelling capacity to provide a financial dimension to forecasting by estimating losses and determining capital requirements. This improved understanding of uncertainty allows insurers to appropriately adjust their pricing of premiums and deductibles or even decide not to take on the risk themselves, either through the mechanism of risk transfer, for example, through the use of reinsurers, or by avoiding the risk altogether if deemed to be uninsurable.
This increasingly common case of uninsurability has given rise to innovative solutions where traditional insurance products might not be suitable for these use cases. A common example of such innovations is parametric insurance, which facilitates rapid payouts based on predetermined thresholds as they are met, such as wind speeds and volume of rainfall, rather than requiring customers to make a claim and wait for reimbursement in the wake of a catastrophic event. The agricultural sector particularly favours this method of parametric insurance because it simplifies much of the risk assessment process and provides quick access to funds, enabling farmers to promptly respond to business interruptions.
Further acknowledgement of the risks from extreme weather events has also been formalised in Italy; as of January 2025, it has been made mandatory for all companies to purchase insurance to provide cover against natural hazards such as floods and wildfires.
Evolving approach of the lending sector
The lending market has been adapting to increasing physical climate risks, with lenders improving their integration of climate risk data and analytics to embed climate risk into their financial risk strategy, with the most relevant example being credit risk analysis. IAMs are developed and utilised to make predictions over loan safety, allowing lenders to gain more insights into how natural hazards impact the Probability of Default (PD), Loss Given Default (LGD), Exposure at Default (EAD), and also the Loan-to-Value (LTV) of owned assets (the ratio of a loan to the total value of an asset).
Central Banks and stress testing feedback
Since recent exercises for climate stress testing have taken place, valuable insights into how banks are managing climate-related risks have been gathered. The 2022 European Central Bank (ECB) Climate Stress Test looked at both transition and physical risk (flood risk and drought & heat risk). Between the 41 banks asked to provide projections of losses, €70 billion of aggregate losses was reported for three short-term exercises (3-year disorderly transition and two 1-year physical risk scenarios), with advice to treat this value as an underestimation.The findings show that banks are sensitive to credit losses from both transitional and physical risks, particularly in the mining and construction sectors under the drought and heat assessment. While progress was made in incorporating climate risks into reporting, banks faced challenges in data availability. Among banks with a climate risk stress-testing framework, 74% included climate-related and environmental events in their operational risk framework, yet only 38% included these events in their reputational risk framework. This finding alludes to recognition from the partaking banks of climate risk as a financially material risk, rather than simply catering to increasing public pressure to be climate conscientious. Following this exercise, the ECB integrated the findings into the Supervisory Review and Evaluation Process (SREP) and published a thematic review outlining good practices for climate-related and environmental risk management.
In its 2021 Climate Biennial Exploratory Scenario (CBES) report, the Bank of England looked at both physical and transition risks. It found that banks could face significant credit losses in all three scenarios: Early Action (EA), Late Action (LA), and No Additional Action (NAA). The exercise found that, although some firms demonstrated well-developed quantitative climate risk modelling and incorporation into risk management frameworks, scenario analysis processes were not sufficiently developed to enable effective decision-making.
Following the CBES exercise, the Bank of England's Climate Financial Risk Forum (CFRF) has been actively working with firms to address climate-related financial risks. The CFRF has created comprehensive guides on climate-related risk management, scenario analysis, disclosure, and innovation, which have been added to with further handbooks on transition and nature-related risks and mobilising adaptation finance.
Following the CBES exercise, the Bank of England's Climate Financial Risk Forum (CFRF) has been actively working with firms to address climate-related financial risks. The CFRF has created comprehensive guides on climate-related risk management, scenario analysis, disclosure, and innovation, which have been added to with further handbooks on transition and nature-related risks and mobilising adaptation finance.
The Bank of England has offered guidance and feedback on climate risk management to CEOs and CFOs. Leaders are encouraged to invest in high-quality data and modelling, integrate climate risk assessments into strategic and financial planning, be transparent in their reporting of exposures, and participate in industry working groups in the interests of sharing knowledge and expertise. In its most recent Financial Stability Report, the Bank of England addresses climate risk as a major global risk for both private and public finances. As such, stress testing activities will continue to take place, with future mandates set to include specific risks that are anticipated to be driving a changing climate.
How can Royal HaskoningDHV help you on your climate risk & resilience journey?
Enhanced Risk Modelling
Integrate hazard data into existing frameworks and strategies to make sure you’re not underestimating your risk.
Scenario Analysis & Stress Testing
Test your resilience under different emissions scenarios and act to mitigate any risks.
Lead in Compliance
Don’t just tick the box, lead by example, and create a culture of transparent climate-related disclosures.
Expert Climate Advice
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